CAF9 audit and assurance study text

2015

AUDIT AND
ASSURANCE
STUDY TEXT

CAF-09



ICAP

P

Audit and Assurance


Second edition published by
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Certificate in Accounting and Finance
Audit and Assurance

C
Contents
Page

Syllabus objective and learning outcomes

v

Chapter
1

Concept and need for assurance

2

Obtaining an engagement

25

3

Planning and risk assessment

37

4

Evidence and sampling

71

5

Internal control

95

6

Flowcharts and IT concepts

127

7

Tests of controls

143

8

Introduction to substantive procedures

175

9

Substantive procedures: non-current assets

197

10

Substantive procedures: current assets

209

11

Substantive procedures: other areas

239

12

Related party transactions

261

13

Reliance on others

271

14

Professional ethics and codes of conduct

291

15

Audit finalisation and reporting

307

16

International standards on review engagements

365

Index

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Audit and Assurance

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Certificate in Accounting and Finance
Audit and Assurance

S

Syllabus objective

and learning outcomes
CERTIFICATE IN ACCOUNTING AND FINANCE
AUDIT AND ASSURANCE
Objective
To acquire knowledge of theory, skill, techniques of auditing and to enable the students to
understand International Standards on Auditing, Assurance and Ethics.

Learning Outcome
On the successful completion of this paper candidates will be able to:
1

Demonstrate knowledge of general concepts governing an audit

2

Demonstrate working knowledge in respect of performance of simple audit
procedures and understand the audit report requirements under the Companies
Ordinance, 1984 and under the International Standards for Auditing (ISAs)

3

Understand the requirement and application guidelines relating to some of the
specific areas of audit procedures including external confirmation, review of
subsequent event etc.

4

Comprehend nature of engagements of review of financial statements

5

Demonstrate familiarity with computer programming and IT controls relevant to
financial reporting

6

Respond on audit matters in the light of fundamental principles given in the Code
of Ethics

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Audit and Assurance

Grid

Weighting

General concepts and principles of audit

15-20

Performance of audit and reporting

25-35

Specific areas

20-25

Computer programming and IT controls

10-15

Professional Ethics

10-15
Total

Syllabus
Ref

A

Contents

Level

100

Learning Outcome

General concepts and principles of audit
1

Introduction to International

Federation of Accountants

1

LO1.1.1: Briefly describe the
organizational overview encompassing



History;
Vision and mission

2

Introduction to international
auditing and assurance
standard setting body

1

LO1.2.1: Briefly describe the objectives
and functions of IAASB

3

Objective and general
principal governing an audit
(ISA 200)

2

LO1.3.1: Describe the objectives of
audit including concepts of
accountability, stewardship, agency,
independence and fair presentation
LO1.3.2: Describe the overall
objectives of the independent auditor
LO1.3.3: Describe the concepts of
assurance and levels of assurance i.e.
absolute, reasonable and limited
assurance including elements of an
assurance engagement, assurances
provided by audit and review
engagement
LO1.3.4: Explain the requirement of an
external audit, eligibility and ineligibility
of auditor
LO1.3.5: Describe the rights and duties
of auditors
LO1.3.6: Explain the nature and scope
of an audit designed to enable the
independent auditor to meet those
objectives

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Syllabus and study guide

Syllabus
Ref

Contents

Level

Learning Outcome
LO1.3.7: Outline the requirements
establishing the general responsibilities
of the independent auditor applicable in
all audits including consideration of
inherent limitation of an audit
LO1.3.8: Discuss the concept of
professional scepticism

4

Responsibility for the
financial statements

2

LO1.4.1: Understand the responsibility
of management and those charged with
governance for financial reporting and
related internal control on financial

reporting

5

Auditors responsibility to
consider fraud (ISA 240)

2

LO1.5.1: Distinguish between the terms
‘error’, ‘fraud’ and misstatement’
LO1.5.2: Compare the respective
responsibilities of management and
auditors for fraud
LO1.5.3: Describe the matters to be
considered and procedures to be
carried out to assist the auditor in
identifying, assessing and detecting the
risks of material misstatement due to
fraud
LO1.5.4: Identify the fraud risk factors
in the simple scenario as given in the
appendix 1 of ISA 240
LO1.5.5: Identify the circumstances
that indicate the possibility of fraud in
the simple scenario as given in the
appendix 3 of ISA 240

6

Legal consideration relating
to appointment and removal
of auditors (sections 252 to
260 of the Companies
Ordinance 1984)

2

LO1.6.1: Explain how the first and
subsequent auditors are appointed
LO1.6.2: Explain how the first and
subsequent auditors are removed
LO1.6.3: Explain the procedure of
resignation of auditors.
LO1.6.4: Describe qualification and
disqualification of the auditor
LO1.6.5: Describe the powers and
duties of auditors
LO1.6.6: Describe the concept of audit
of cost accounts

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Audit and Assurance

Syllabus
Ref

Contents

Level

Learning Outcome
LO1.6.7: Discuss the additional matters
to be included in the auditor’s report
LO1.6.8: Discuss the auditor’s
responsibilities with respect to
attendance at general meeting and
access to books and records

7

Terms of Audit
engagements (ISA 210)

2

LO1.7.1: Describe the preconditions for
an audit and upon which it is necessary
for the auditor and the entity’s
management to agree
LO1.7.2: Respond if preconditions are
not present or limit is imposed on scope
of audit in well explained simple
situations

LO1.7.3: State the contents of an audit
engagement letter
LO1.7.4: Discuss the requirement of
issuance of engagement letter and
factors that necessitate the issuance of
engagement letter in case of recurring
audit
LO1.7.5: Discuss the circumstances of
acceptances of changes in terms of
engagement by the auditor

B

Performance of audit and reporting
1

Planning an audit (ISA 300)

2

LO2.1.1: Discuss the need for planning
an audit including contents of an audit
plan and its relation with risk
assessment
LO2.1.2: Discuss the contents of
overall audit strategy and audit plan
LO2.1.3: State who should be involved
in planning and what preliminary
engagement activities are necessary
LO2.1.4: Discuss overall planning and

the audit plan for a recurring audit
LO2.1.5: Outline the additional
considerations that should be identified
while planning the initial audit

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Syllabus and study guide

Syllabus
Ref

2

Contents
Assessment of audit risks
(ISA 315 and 330)

Level
2

Learning Outcome
LO2.2.1: Discuss the risk based
approach to auditing including audit risk
model

LO2.2.2: Identify the inherent risk,
control risk and detection risk
in simple scenario
LO2.2.3: Explain relationship between
audit risk and its components i.e.
inherent risk, control risk and detection
risk
LO2.2.4: Discuss the identification and
assessment of the risks of material
misstatement at both the financial
statement level and assertion level,
including understanding of entity, its
environment, accounting and internal
control systems
LO2.2.5: Explain the elements of
internal control
LO2.2.6: Discuss the evaluation of
controls and control environment and
communication of deficiencies to the
management
LO2.2.7: Explain the categories of
control activities (internal controls) by
using simple examples including
Application and General IT Controls
LO2.2.8: Differentiate between control
activities relevant and irrelevant to audit
in a well explained scenario
LO2.2.9: Explain and identify the
control weaknesses in the given
scenario and suggest appropriate

recommendations to remove these
weaknesses
LO2.2.10: Discuss and explain the
limitations of internal control system
LO2.2.11: Discuss and explain the risks
in specialized IT systems
LO2.2.12: Explain the different
methods of recording internal control
systems

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Audit and Assurance

Syllabus
Ref

Contents

Level

Learning Outcome

3

Audit materiality (ISA 320)

2

LO2.3.1: Explain the concepts of
materiality and performance materiality
using simple examples

4

Audit evidence (ISA 500)

2

LO2.4.1: Explain, using examples,
sufficient appropriate audit evidence
LO2.4.2: Discuss the general principles
assisting the auditor in assessing the
relevance and reliability of audit
evidence
LO2.4.3: Discuss audit procedures to
obtain audit evidence including types of
audit procedures
LO2.4.4: Discuss the course of action
available to auditor in case sufficient
appropriate audit evidence is not
obtained.
LO2.4.5: Explain the financial
statement assertions including
assertions about class of transactions,

account balances and presentation and
disclosure
LO2.4.6: Explain what information can
be used as audit evidence

5

Audit sampling (ISA 530)

2

LO2.5.1: Explain audit sampling,
statistical sampling and sampling and
non-sampling risk using simple
examples
LO2.5.2: Discuss the relationship
between sampling and audit risk model.
LO2.5.3: Explain what matters are
considered by auditors in respect of
sample design, size and selection of
items for testing using simple examples
including sample selection method.
LO2.5.4: Discuss the concept of
misstatement and rate of deviation
including expected and tolerated
LO2.5.5: State the audit procedures to
be performed on selected sample
LO2.5.6: Discuss the concept of
Projecting misstatement and evaluating
the results of audit sampling

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Syllabus and study guide

Syllabus
Ref

6

Contents
Substantive procedures (ISA
330)

Level
2

Learning Outcome
LO2.6.1: Understand the financial
statement assertions
LO2.6.2: Identify the financial
statement assertions in simple
scenarios
LO2.6.3: Discuss the use of computer
software in substantive testing, auditing

around the computer and directional
testing
LO2.6.4: Discuss the methods of
obtaining audit evidence for substantive
testing
LO2.6.5: Explain the nature, extent and
timing of substantive procedures for
different items of financial statements

7

Tests of controls (ISA 330)

2

LO2.7.1: Explain the nature, extent and
timing of test of controls using simple
examples
LO2.7.2: Explain the concept of
Computer Assisted Audit Techniques
LO2.7.3: Explain how auditors evaluate
the operating effectiveness of controls
using simple examples
LO2.7.4: Explain the controls over
major transaction cycles including
related risks, weaknesses control
objectives and designing appropriate
tests of controls

8

Analytical procedures (ISA
520)

2

LO2.8.1: Explain the nature and
purpose of substantive analytical
procedures using simple examples
LO2.8.2: State the purpose of analytical
procedures performed near the end of
the audit
LO2.8.3: Apply analytical procedures
through calculations of different ratios
for different items of financial
statements

9

Documentation (ISA 230)

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LO2.9.1: Explain the nature and
purpose of audit documentation

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Audit and Assurance

Syllabus
Ref

Contents

Level

Learning Outcome
LO2.9.2: Describe the form, content
and extent of audit documentation
using simple examples
LO2.9.3: Discuss the use of computer
based audit working papers
LO2.9.4: Discuss the ownership,
custody and confidentiality of audit
working papers
LO2.9.5: Understand the nature of
assembly of the final audit file

10

C

Audit opinion and form of
audit report under

International Standards on
Auditing and under the
Companies Ordinance 1984

2

LO2.10.1: Understand modified and
unmodified audit opinion
LO2.10.2: Explain qualified opinion,
disclaimer of opinion and adverse
opinion
LO2.10.3: Explain emphasis of matter
and other matter in the auditor report
LO2.10.4: Discuss the modification of
audit opinion and audit report in
different situations
LO2.10.5: Briefly state the contents of
the auditor’s report under International
Standards on Auditing and under the
Companies Ordinance 1984
LO2.10.6: Explain the differences
between auditor’s report under
International Standards on Auditing and
under the Companies Ordinance 1984
LO2.10.7: State the penalty for noncompliance with provisions related to
the audit report

2

LO3.1.1: Describe the significance of

using external confirmation procedures
for obtaining relevant and reliable audit
evidence
LO3.1.2: Describe the steps involved in
external confirmation procedures

Specific areas
1

External confirmations (ISA
505)

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Syllabus and study guide

Syllabus
Ref

Contents

Level

Learning Outcome
LO3.1.3: Differentiate between the

positive confirmation request and
negative confirmation request, including
their appropriateness in different
situations
LO3.1.4: Discuss the conditions of
sending negative confirmations
LO3.1.5: Discuss the auditor’s course
of action if management refuses to
allow auditor to send confirmation

2

Subsequent events (ISA
560)

2

LO3.2.1: Explain subsequent events
and its relevance with the following
critical dates
a) Date of the financial statements
b) Date of approval of the financial
statements
c) Date of the auditor’s report
d) Date the financial statements are
issued
LO3.2.2: Explain the subsequent
events review procedure
LO3.2.3: Discuss the classification of
subsequent events into adjusting and

non-adjusting events
LO3.2.4: Describe the auditor’s
responsibility in respect of following
situations.
a) Events occurring between the date
of the financial statements and the
date of the auditor’s report
b) Facts which become known to the
auditor after the date of the
auditor’s report but before the date
the financial statements are issued
c) Facts which become known to the
auditor after the financial
statements have been issued
LO3.2.5: Identify the subsequent
events and explain the auditor
responses

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Audit and Assurance

Syllabus
Ref

3

Contents
Written representation (ISA
580)

Level
2

Learning Outcome
LO3.3.1: Discuss the nature of written
representations as audit evidence
LO3.3.2: Discuss the circumstances
where written representations are
necessary and the matters on which
representations are commonly obtained
LO3.3.3: Discuss the form and content
of written representations
LO3.3.4: Discuss the auditor’s course
of action if management refuses to
provide requested written
representation

4

Consideration of related
parties (ISA 550)

2

LO3.4.1: Describe the term related
party using simple examples
LO3.4.2: Discuss how related party
transactions can give rise to the risk of
material misstatement using simple
examples
LO3.4.3: Describe the audit procedures
including risk assessment procedures
and related activities to obtain
information relevant to identifying the
related party relationships and
transactions including responses to the
assessed risk of material misstatement

5

Using the work of
component auditors, internal
audits and auditor’s experts
(ISA 600, ISA 610 and ISA
620)

2

LO3.5.1: Explain the responsibility of
the group engagement partner in
respect of acceptance and continuance,
overall audit strategy, understanding
the group, its component and their
environment, their auditor and

materiality
LO3.5.2: Discuss the planning and
controlling of a group audit, working
and communication with the component
auditor and involvement of the group
auditor in the work performed by
component auditor.
LO3.5.3: Explain the relationship
between the external auditor with
internal auditors and auditor’s experts

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Syllabus and study guide

Syllabus
Ref

Contents

Level

Learning Outcome
LO3.5.4: Explain the internal audit
function including internal audit

activities
LO3.5.5: Discuss the factors
determining the independence of
internal auditors and weaknesses and
limitations of internal audit
LO3.5.6: Discuss how external auditors
determine whether and to what extent
the use the work of internal audit
LO3.5.7: Discuss using examples how
external auditors uses the specific work
of internal audit
LO3.5.8: Discuss how the auditor
assess the work of an expert
LO3.5.9: Discuss how the external
auditor uses the work of an auditor’s
expert when that work is used to assist
in obtaining sufficient appropriate audit
evidence

6

Engagement to review
financial statements (ISRE
2400)

2

LO3.6.1: Explain the objective of a
review engagement of financial
statements and how it differs from audit

LO3.6.2: State the terms of
engagement which may be included in
the engagement letter
LO3.6.3: Describe the procedures
generally adopted by the practitioner to
obtain evidence in review engagements
LO3.6.4: Discuss and explain the report
issued under engagement to review
financial statements

D

Computer programming and IT controls
1

Benefits and limitations of
flowcharts

1

LO4.1.1: State the benefits and
limitation of flowcharts using simple
examples

2

Types of flowcharts

1

LO4.2.1: Classify and distinguish
between types of flowcharts, namely,
linear, deployment and opportunity
flowcharts
LO4.2.2: Describe the macro, mini and
micro level details of flowcharts

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Audit and Assurance

Syllabus
Ref

Contents

Level

Learning Outcome

3

Drawing flowcharts for
specific situations/programs

2

LO4.3.1: Draw different types of
flowcharts for given situations

4

Control design

2

LO4.4.1: Describe appropriate controls
while designing the system using
simple examples

5

General controls

2

LO4.5.1: Describe general controls and
classify them into environment,
development, maintenance and
operational controls using simple
examples

6

Preventative, detective and

corrective controls

2

LO4.6.1: Describe preventative,
detective and corrective controls using
simple examples

7

Audit trails

2

LO4.7.1: Describe the concept of an
audit trail in a computerized
environment using simple examples

8

Logical access controls

2

LO4.8.1: Describe logical access
controls for a given situation/system

9

Physical access controls

2

LO4.9.1: Describe physical access
controls for a given situation/system

10

Program security techniques

2

LO4.10.1: Describe checks/controls
into the software system to protect data
from corruption and unauthorized
access

11

Data security and public
networks

2

LO4.11.1: State controls over data
transmission
LO4.11.2: Describe data encryption
techniques for transmission of data
over public networks
LO4.11.3: Describe communications

protocol
LO4.11.4: Understand the Open
System Interconnection (OSI) model

12

Monitoring and surveillance
techniques

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LO4.12.1: Describe the usefulness of
system logs for analyzing a system’s
performance

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Syllabus and study guide

Syllabus
Ref

E

Contents

Level

Learning Outcome

Professional ethics
1

Fundamental principles
(sections 100 to 150 of the
Code of Ethics for Chartered
Accountants)

2

LO5.1.1: Describe with simple
examples the fundamental principles of
professional ethics of integrity,
objectivity, professional competence
and due care, confidentiality and
professional behavior
LO5.1.2: Apply the conceptual
framework to identify, evaluate and
address threats to compliance with
fundamental principles
LO5.1.3: Understand the threats and
circumstances that cause threats of
self-interest, self-review, advocacy,
familiarity, and intimidation
LO5.1.4: Discuss the safeguards to

offset the threats to compliance with the
fundamental principles
LO5.1.5: Discuss the concept of ethical
conflict resolution

2

Client and engagement
acceptance (section 210 of
the Code of Ethics for
Chartered Accountants)

2

LO5.2.1: Explain the advertisement and
publicity guidelines of ICAP Code of
Ethics for obtaining the audit work.
LO5.2.2: Apply the conceptual
framework to identify, evaluate and
address threats in case of fees, referral
fees and tendering for audit work.
LO5.2.3: Explain using simple
examples the matters to be considered
and the procedures that an audit
firm/professional accountant should
carry out in the following
circumstances:




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Client acceptance
Engagement acceptance
Changes in a professional
appointment (including
Additional work, mid-term
removal and nonreappointment)

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Audit and Assurance

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CHAPTER

Certificate in Accounting and Finance
Audit and Assurance

1

Concept and need for assurance
Contents
1 The meaning of audit
2 The meaning of assurance
3 Statutory audit - the regulatory framework
4 International Standards on Auditing (ISAs)
5 Advantages and limitations of statutory audits
6 Chapter review

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Audit and Assurance

INTRODUCTION
Learning outcomes
The overall objective of the syllabus is acquiring knowledge of theory, skill and techniques of
auditing and to enable the students to understand International Standards on Auditing,
Assurance and Ethics.
General concepts and principles of audit
LO 1

On the successful completion of this paper, candidates will be able to
demonstrate knowledge of general concepts governing an audit

LO 1.1.1

Briefly describe the organizational overview encompassing:
- History
- Vision and mission

LO 1.2.1

Briefly describe the objectives and functions of IAASB

LO 1.3.1

Describe the objectives of audit including concepts of accountability,
stewardship, agency, independence and fair presentation

LO 1.3.2

Describe the overall objectives of the independent auditor

LO 1.3.3

Describe the concepts of assurance and levels of assurance i.e. absolute,
reasonable and limited assurance including elements of an assurance
engagement, assurances provided by audit and review engagement

LO 1.3.4

Explain the requirement of an external audit, eligibility and ineligibility of
auditor

LO 1.3.5

Describe the rights and duties of auditors

LO 1.3.6

Explain the nature and scope of an audit designed to enable the independent
auditor to meet those objectives

LO 1.3.7

Outline the requirements establishing the general responsibilities of the
independent auditor applicable in all audits including consideration of inherent
limitation of an audit

LO 1.4.1

Understand the responsibility of management and those charged with
governance for financial reporting and related internal control on financial
reporting

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Chapter 1: Concept and need for assurance

1

THE MEANING OF AUDIT
Section overview


Definition and objective of audit



Concepts of accountability, stewardship and agency



The audit report: independence, materiality and true and fair



The statutory requirement for audit

1.1 Definition and objective of audit
An audit is an official examination of the accounts (or accounting systems) of an
entity (by an auditor).
When an auditor examines the accounts of an entity, what is he looking for?
The main objective of an audit is to enable an auditor to convey an opinion as to
whether or not the financial statements of an entity are prepared according to an
applicable financial framework.
The applicable financial reporting framework is decided by:


legislation within each individual country, and



accounting standards (for example, International Accounting Standards/
International Financial Reporting Standards).

The auditor seeks to express an opinion as the result of the audit work that he
does. The type of work carried out by an auditor in order to reach his opinion is
described in later chapters.

1.2 Concepts of accountability, stewardship and agency
An audit of a company’s accounts is needed because in companies, the owners
of the business are often not the same persons as the individuals who manage
and control that business.


The shareholders own the company.



The company is managed and controlled by its directors.

The directors have a stewardship role. They look after the assets of the
company and manage them on behalf of the shareholders. In small companies
the shareholders may be the same people as the directors. However, in most
large companies, the two groups are different.
The relationship between the shareholders of a company and the board of
directors is also an application of the general legal principle of agency. The
concept of agency applies whenever one person or group of individuals acts as

an agent on behalf of someone else (the principal). The agent has a legal duty
to act in the best interests of the principal, and should be accountable to the
principal for everything that he does as agent.
As agents for the shareholders, the board of directors should be accountable to
the shareholders. In order for the directors to show their accountability to the
shareholders, it is a general principle of company law that the directors are
required to prepare annual financial statements, which are presented to the
shareholders for their approval.

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Audit and Assurance

1.3 The audit report: independence, materiality and true and fair
Audit has a very long history. The concept of an audit goes back to the times of
the Egyptian and Roman empires. In medieval times, independent auditors were
employed by the feudal barons to ensure that the returns from their stewards and
their tenants were accurate.
Over time, the annual audit was developed as a way of adding credibility to the
financial statements produced by management. The statutory audit is now a key
feature of company law throughout the world.
An auditor reports to the shareholders on the financial statements produced by
a company’s management.

The key features of the audit report are as follows:



The auditors producing the report are independent from the directors
producing the financial statements



The report gives an opinion on whether the financial statements “give a
true and fair view”, or “present fairly” the position and results of the
entity.



The report considers whether the financial statements give a true and fair
view in all material respects. The concept of materiality is applied in
reaching an audit opinion.

Independence of the auditor
The external auditor must be independent from the directors; otherwise his
report will have little value. If he is not independent, his opinion is likely to be
influenced by the directors.
In contrast to external auditors, internal auditors may not be fully independent
from the directors, although they may be able to achieve a sufficient degree of
independence.
True and fair view (fair presentation)
The auditor reports on whether (or not) the financial statements give a true and
fair view, or present fairly, the position of the entity as at the end of the financial
period and the performance of the entity during the period. The auditor does not
certify or guarantee that the financial statements are correct.
Although the phrase ‘true and fair view’ has no legal definition, the term ‘true’

implies free from error, and ‘fair’ implies that there is no undue bias in the
financial statements or the way in which they have been presented.
In preparing the financial statements, a large amount of judgement is exercised
by the directors. Similarly, judgement is exercised by the auditor in reaching his

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Chapter 1: Concept and need for assurance

opinion. The phrases ‘true and fair view’ and ‘present fairly’ indicate that a
judgement is being given that the financial statements can be relied upon and
have been properly prepared in accordance with an appropriate financial
reporting framework.
Materiality concept
The auditor reports in accordance with the concept of materiality. He gives an
opinion on whether the financial statements present fairly in all material
respects the financial position and performance of the entity.
Information is material if, on the basis of the financial statements, it could
influence the economic decisions of users should it be omitted or misstated.
For example, the shareholders of a company with assets of Rs.1 million will not
be interested if petty cash was miscounted with the result that the amount of
petty cash is overstated by Rs.100. This is immaterial. However, they will be
interested if there are receivables in the statement of financial position of
Rs.200,000 which are not in fact recoverable and which should therefore have
been written off as a bad debt.

Applying the concept of materiality means that the auditor will not aim to examine
every number in the financial statements. He will concentrate his efforts on the
more significant items in the financial statements, either:


because of their (high) value, or



because there is a greater risk that they could be stated incorrectly.

1.4 The statutory requirement for audit
Most countries impose a statutory requirement for an annual (external) audit to
be carried out on the financial statements of most companies.
However, in many countries, smaller companies are exempt from this
requirement for an audit. Other entities, such as sole traders, partnerships, clubs
and societies are usually not subject to a statutory audit requirement. Small
companies and these other entities may decide to have a voluntary audit, even
though this is not required by law.

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The Institute of Chartered Accountants of Pakistan